Revisiting financial opening and financial development: A regulation heterogeneity perspective

Abstract

Economies worldwide are carrying out financial opening reforms to regain economic momentum. However, current studies about the effect of financial opening on financial development provide conflicting results. Based on the performances of financial markets in different regulatory settings, we argue that the quality of regulation plays a vital role in determining the effect of financial opening. We apply the dynamic panel threshold model to the data of 114 economies ranging from 2008 to 2019 to estimate the existence of financial regulation thresholds and the impact of financial opening on the depth and efficiency of financial development. Results demonstrate that financial opening in less-regulated markets accelerates credit market expansion; however, it does not concurrently foster improvements in financial efficiency. Although the expansion effect is less remarkable in well-regulated markets, there is a discernible enhancement in overall efficiency. We conclude that regulatory capacity-building is a significant precondition for effective financial opening. Our research provides policy implications for enhancing regulatory quality and warning off financial “deregulation”, especially for emerging economies. Policymakers are tasked with the imperative duty of achieving a delicate equilibrium between reaping the advantages of financial liberalization and mitigating the prospective hazards associated with financial deregulation. This nuanced approach holds paramount importance in nurturing a financial system that is both enduring and robust.